I began writing columns for the Herald Tribune in March 2008. My second article, entitled “To Bear Stearns’ shareholders, JPMorgan CEO is no Goldilocks,” discussed JPMorgan’s proposed acquisition of Bear Stearns at a severely discounted price.
Over the next six months, famous Wall Street names were either taken over or needed government intervention to survive.
The government seized control of Fannie Mae and Freddie Mac. Bank of America acquired Merrill Lynch under duress. Lehman Brothers failed. The government ultimately infused $180 billion to save AIG.
To prevent a depression, the government infused billions of dollars into leading financial firms and provided trillions of dollars of liquidity through guarantees on a wide range of instruments, including money market funds and commercial paper.
In brief, we were living in tumultuous times that encouraged government intervention on an unprecedented scale.
Five years later, much has changed.
The Dow Jones Industrial Average, which measures the performance of 30 blue-chip companies, closed Tuesday at 14,253, surpassing its previous record close of 14,164.
Since a low point in March 2009, the Dow Jones index has more than doubled, stunning even the most seasoned stock market watchers. After the crash of 1929, it took 25 years for the Dow to recover.
Our commercial banks are operating comfortably in the black. AIG has repaid all of its government borrowing. Fannie Mae and Freddie Mac, for the first time since 2006, were profitable in 2012.
Why is the Dow so high when we have some major fiscal problems, such as continued trillion-dollar federal deficits?
The effort by the Federal Reserve to keep interest rates ultra low has encouraged investors to put more money into riskier assets, such as the stock market and junk bonds. The market is at record highs and junk bond yields are at record lows. For the time being, Wall Street has shrugged off the negative economic consequences of the federal sequester.
The Fed is providing a major psychological shot in the arm. I agree with David Rosenberg, chief economist at Gluskin Sheff, who recently told the New York Times, “So long as the Fed is in an accommodative mode and the economy is out of recession, the odds are that you will have a bull market.”
Corporate profits are at all-time high. The American corporate sector is in a lot better health than the overall economy.
Dean Maki, chief economist at Barclays, was quoted in the New York Times earlier this month saying that, “As a percentage of national income, corporate profits stood at 14.2 percent in the third quarter of 2012, the largest share at any time since 1950, while the portion of income that went to employees was 61.7 percent, near its lowest point since 1966.”
With millions still out of work, companies face little pressure to raise salaries. Companies are also benefitting from productivity gains that allow them to increase sales without adding workers.
Alan Blinder, a former Fed vice chairman, tried to explain to the Times why the stock market is doing well while most people are not doing particularly well: “A bet on an index like the Dow is effectively a narrow wager on the profits of 30 companies, not necessarily the economic health of average Americans.”
Yes, things are going well, for many. But over the next five years, I see some black clouds.
I cannot understand how the Federal Reserve can unwind its balance sheet from less than $1 trillion in 2007 to more than $3 trillion today without causing a major contraction in the economy and a rise in interest rates.
Currently, the Fed is purchasing $85 billion of government debt monthly. When private bond investors replace the Fed, they will require significantly higher yields than our central bank does.
Furthermore, I remain dubious that our elected officials can make logical budget cuts on the scale necessary to put us on a fiscally sound course.
Originally published in the Sarasota Herald-Tribune
